At the time, just after the Nasdaq Composite had peaked above 5000, Cisco stood athwart the then-massive demand for Internet networking and switching equipment, the company's market value was close to $500 billion, its shares were just under $70 and fetched 130 times that year's consensus profit forecast, a massive premium to a vastly expensive stock market. Then, investors were giving Cisco far too much credit for growth prospects in perpetuity, and management was busy throwing around its overpriced shares willy-nilly to pay for acquisitions.

Today, the situation is almost precisely inverted.
Ciscocsco 0.3672787979966611%Cisco Systems Inc.U.S.: NasdaqUSD30.06
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P/E Ratio
14.314285714285715Market Cap
150341779562.194
Dividend Yield
3.4597471723220226% Rev. per Employee
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(ticker: CSCO) remains admirably managed, a leading survivor of several waves of technological change across the industry. Indeed, the company is a good deal more diverse, with deeper leadership, than it was a decade ago. And Cisco shares, now hovering under 20, trade about 12 times the recently reduced forecast earnings for the fiscal year ending next July, at an unmerited discount to a reasonably valued stock market. Investors, making the opposite error they made in 2000, have priced in too much skepticism about Cisco's growth prospects and market-share position, making the stock an attractive opportunity for patient buyers.

SHOULD CISCO EVEN COME CLOSEto its stated long-term objective of posting 12% to 17% annualized revenue growth over a market cycle, the stock should at least trade back toward its 2010 high above 27. That would indicate investors have gained confidence in Cisco's ability to defend its core product markets while expanding its presence in newer areas, such as data-center management, digital conferencing and consumer communications.

The investment community, at the moment, isn't much interested in hearing about Cisco's longer-term growth. The Street is holding a bit of a grudge against the San Jose, Calif., concern for its surprising downgrade of its revenue and profit outlook, delivered after its solid earnings report for its first quarter, ended Oct. 31.

On Nov. 10, Cisco reported quarterly earnings of 42 cents a share (excluding, as most tech companies do, stock-based compensation expenses), a couple of pennies ahead of forecasts. But Cisco blindsided the Street with second-quarter guidance that reflected a $500 million sales shortfall from hard-put state and local government customers and a slowdown in its cable set-top-box division.

The stock, to use a phrase used by President Obama in describing the Democrats electoral experience, took a shellacking, losing more than 15% of its market value in a day. It has remained weak, conspicuously underperforming a recently strong technology sector and the market as a whole, bringing year-to-date losses to 18.3%.

Deflated Tech Titan

Whereas Cisco System once traded at a sky-high price/earnings ratio, the company's stock price and valuation now are quite subdued and probably don't reflect its excellent long-term prospects.

The brutal market result was reminiscent of some other unpleasant surprises dealt by companies that had built up a formidable reputation for delivering results as promised, such as Philip Morris and Procter & Gamble did at times in the 1990s.

The transcript from its earnings conference call features pointed questions by analysts about how Cisco's internal sales forecasts fell so wide of the mark, and even whether the company ramped up its share-buyback activity once it saw the order book thinning out late in the quarter. The crowd seems to have concluded that Cisco was undergoing troubles specific to itself, rather than broader demand pressures tied to economic headwinds.

John Chambers, chief executive of Cisco since 1995, insists that his team didn't take the latest disappointment lightly. "Any time there's constructive criticism or challenges, or a stock price with a P/E [ratio] that implies profit growth in the high single digits, we've got to say, 'Is there something you're missing on market transitions?' "

His conclusion, after an extensive review of the business: No.

Chambers points to two other times when what was first deemed a "Cisco-specific" issue was later seen as Cisco being simply an early bellwether of larger trends, in part due to the company's expansive customer set and somewhat because its unusual fiscal calendar tends to capture the first or second month of rivals' quarters before they report them. In 2007, Cisco detected a severe slowdown in revenue from financial firms. Then, right at the spring 2009 market turn, it signaled an uplift in business activity before the market anticipated one.

"UNLESS WE'RE MISSING SOMETHING," he says, "things are playing out exactly as we thought they would." If he's right, large corporate technology buyers have become less interested in a product-by-product sales proposition than in a set of "architectural" solutions, with one or a few providers offering integrated solutions to manage their data centers and other crucial information-technology functions.

Cisco executives point out that this has long been the company's strategic premise since the go-go days of the Internet build-out ended soon after the turn of the century. Cisco expanded beyond its core router and switches businesses into Internet telephony, security systems, video services, Flip MinoHD video cameras, servers and products for the "networked home," including a high-end home video-conferencing system now being marketed to the early-adopter set called Umi (pronounced "you me" – get it?)

Two of Cisco's many products, from left, a Linksys wireless router for home computer networks and components of the company's Umi Telepresence system for consumers.
courtesy Cisco

The company, prideful about its ability to see around corners toward the next industry trend and then rush there (often by buying early-stage companies), likes to note that what once was the "core" of its business–routing hardware–now represents a mere 16% of its revenue. This helps explain how Cisco outmaneuvered companies once considered its peers, such as
Alcatel-Lucent
(ALU) and
Nortel Networks
(NRTLQ). Contrary to the common bearish view, Cisco isn't a slow-moving incumbent vendor fixated on protecting its 70% share in network switches.

For all the angst expressed by analysts over actual and feared market-share erosion, Cisco increased its share in 12 of its 15 major product lines last quarter versus a year earlier.

All that being said, the notion that large customers will increasingly demand integrated product and software solutions from their vendors is no longer a secret to Cisco's most important competitors, which include a couple that are making aggressive efforts to poach customers in some of the business lines that it most dominates.

Chambers, while acknowledging the competition among big companies each seeking inroads into others' dominant markets, contends that Cisco has an advantage: its background in networking, rather than pure enterprise software or mainframe computing.

"We're fortunate to be in the right industry," he says. "The network is the platform for everything else in the market–cloud computing, collaboration, productivity.… The more intelligence that goes into [the network], the better for us."

When the shares of world-class companies get cheap enough, the investment decision can sometimes be justified simply: The total market is growing faster than the world economy, and the leading companies in this market will get at least their share of the growth and can leverage that into above-average profit gains.

Consider that, by Cisco's numbers, video will rise to 64% of telecom and cable carriers' traffic by 2013, from 4% today, and will represent some 90% of total traffic growth in that period. Such secular expansion of the market for network-dependent data flow represents a tremendous, and underappreciated, opportunity for Cisco.

"I think the stock has been overly beaten up because of a lot of near-term concerns," says Fayad Abbasi, an analyst at Neuberger Berman. "When people get comfortable with the 9% to 12% growth"–Cisco's current full-year revenue-growth guidance–"the stock should do OK." Abbasi thinks the shares should trend toward only a "slight discount" to the broad market, until investors are assured that no dramatic market-share changes are afoot. Cisco last quarter strayed from its policy of not offering full-year guidance, but Abbasi points out that in the past when Cisco has done so, it has reliably met or beaten its own targets.

ALSO WORTH CONSIDERING: Street earnings forecasts for fiscal 2011, now at $1.61 per share, reflect revenue estimates near the low end of Cisco's own prediction, a rarity and perhaps a sign of that excessive skepticism.

Oppenheimer analyst Ittai Kidron, who was appropriately cautious on the stock heading into the November earnings report, upgraded it to a Buy a few weeks ago, arguing that sentiment toward Cisco was troughing and that all likely market-share losses had already been reflected in prevailing profit estimates. He has a price target of $23, about 18% above the current price.

Aside from Cisco's operating prospects, its balance sheet is both powerful and a potential opportunity for enhancing shareholder returns down the road.

MORE THAN THREE-QUARTERS of Cisco's cash is held overseas and thus not immediately accessible by the company without incurring a serious tax bill. Chambers and his colleagues have been vocal in advocating for a measure to permit the repatriation of corporate cash, tax-free, so that it might ramp up investments in the business and share cash with shareholders.

Chambers (who was among the CEOs who met with President Obama this month to discuss the administration's economic policies) recently said he thinks that the odds are better than 50-50 in favor of some relief on repatriation of cash, and has said the company would use most of it to accelerate hiring plans.

The company has also stated its intention of initiating a common-stock dividend early next year, with what Cisco promises will be a "competitive" yield. But the payout's size will depend in part on whether reimporting the cash hoard free of taxes is permitted.

The dividend will likely create some valuation support and some measure of discipline for an already-conservative company in terms of its finances. Cisco already buys back enormous amounts of stock—$2.5 billion last quarter alone and $65 billion since fiscal 2002.

A new payout is no panacea for under-loved Big Techs, as Microsoft can attest. But it could be the first step toward ending the Cisco skid.